At a recent event, I was chatting with a woman who was telling me how she had recently retired. She was travelling the country with her husband, and enjoying this new chapter of her life. She explained how she had been with her company for almost 30 years, and how thrilled she was to recently learn that “the company had been putting half of her paycheck away for her all those years.” While that was not exactly the case, what she was describing was a defined benefit plan, or your “grandfather’s pension” as you may sometimes hear it referred to. Source: NLG
While my new friend is lucky to have earned a pension, this conversation also highlights how important it is to educate yourself about the benefit options you have while working, and what benefits you have coming to you at retirement.
Let’s look at two types of pensions:
Defined Benefit Plan
With a defined benefit plan, or traditional pension, the amount of money that you will receive at retirement is known. The employer (or a third party) manages a pension fund, which makes payments to retirees and their surviving beneficiaries, if applicable.
As retirement liabilities and costs skyrocketed, many companies discontinued or converted defined benefit plans. According to the U.S. Bureau of Labor Statistics, as of 2012 only 18% of employees in private industries were covered by a defined benefit plan. Many employers also stopped offering plans to new employees. In 2011, 25% of participants were in “frozen” plans and one-third of those are no longer accruing benefits. By comparison, in 1981, a full 84% of private sector employees were covered by a defined benefit plan.*
Defined Contribution and Cash Balance Plans
In addition to freezing plans, some employers transitioned to cash balance plans. In this model, which is technically still a type of defined benefit plan, an employer starts with a lump sum amount, then credits the employee a certain percentage of their salary each year. These plans are not as lucrative as a traditional defined benefit plan, though they are still more beneficial than a plan that has been discontinued altogether. Cash balance plans naturally favor younger workers, who are able to capitalize on the growth of their money over time. The plan benefit amount is based on current valuation, not the future retirement date of the employee.
A defined contribution plan, on the other hand, is actually not a pension plan, but a retirement account that operates much like a 401(k). Usually both the employer and the employee contribute, and investment accounts are managed within the plan. This type of plan shifts the risk to the employee and lessens the obligation of the employer.
If you had a pension at a former employer, you may still receive a benefit when you reach retirement age. As long as you were vested, meaning that you met the requirements–typically for years of service, you can still potentially receive a payout.
Be sure and keep important statements or correspondence about your retirement benefits, and make sure that former employers have your current address so they can communicate with you about your existing benefits.
How long will your retirement savings last?
Investments can be offered solely by representatives registered to offer such products through a broker/dealer. Distributions from retirement plans are taxed as ordinary income and, if taken prior to reaching age 59½ may be subject to an additional 10% federal income tax penalty.
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